Buyers, lenders jump back into market as opportunity grows

In the second half of 2010, Silicon Valley’s commercial real estate market showed significant signs of improvement, proving once again to be one of the most resilient property markets in the country.

Pent-up demand for office space fueled new leases in the valley, such as NetLogic Corp.’s 105,000-square-foot lease in Santa Clara, as well as several notable expansions, including AOL’s 225,000-square-foot lease in Palo Alto and Apple’s 350,000-square-foot lease in Cupertino.

Large lease renewals were also prevalent throughout the valley, including Palm’s 288,000-square-foot lease renewal in Sunnyvale and Nvidia’s 500,000-square-foot lease renewal in Santa Clara.

We view 2010 as a “snap-back” year, considering the dramatic change in what we term the “tenants in the market” indicator.

“Tenants in the market” for Silicon Valley space had dropped to a low of 5 million square feet during the summer of 2010, but recently bounced back to nearly 10 million square feet. This is an important benchmark, because Silicon Valley is considered healthy when numbers range between 7 and 9 million square feet of lease requirements. Many of these tenant requirements will translate into new leases and positive absorption in 2011.

Cornish & Carey Commercial Newmark Knight Frank forecasts a resurgence in Silicon Valley’s office leasing market in 2011 to more than 1 million square feet of net office absorption in the first half of the year. In contrast, the first half of 2010 experienced a decrease in net absorption of 75,000 square feet.

Much like past recoveries, we are encouraged by the rapid improvement of the Palo Alto, Menlo Park and Cupertino markets, as evidenced by decreased vacancy rates and rising rents. We expect that trend in decreasing vacancy rates to extend into the South Peninsula and South Bay markets of Mountain View, Sunnyvale, and possibly as far as Santa Clara, Sunnyvale and North San Jose in 2011.

Investment sales of large Silicon Valley commercial real estate product also increased significantly in 2010 due to a resurgence in available debt capital and more favorable market conditions.

While debt capital was accessible in 2010, there was a limited pool of properties listed or available for sale. In 2011, we see a change as owners take advantage of a stronger investment market and the first opportunity since 2007 to sell properties for more than their debt amounts.

We forecast $1 billion to $1.5 billion in Silicon Valley investment sales to close during the first half of 2011.

This year also marked the commercial mortgage-backed securities markets slowly coming back to life, breathing liquidity into the capital markets. Relatively low-cost debt is once again available from banks, life insurance companies, high-yield debt funds and commercial mortgage-backed security lenders.

However, lending is now, more than ever, focused on quality of sponsor and in-place cash flow. From 2005 to 2008, lenders were more focused on putting capital to work than on the quality of the asset, leasing market conditions, or the strength of the entities to which they lent.

In addition, lenders underwrote on pro forma rent growth rather than actual in place net operating income.

While more conservative today, most lenders are jumping back into the market with increased allocations going forward. We are confident that this increase in liquidity combined with increased scrutiny will create an investment sales market that is both healthy and sustainable in 2011.